Is It Time to Raise Your Deposit Rates?
The greatest determiner of profitability in a financial institution is interest margin (the difference between the interest paid on deposits and borrowed money and the interest earnings on loans and investments).
This means, one of the most important duties a credit union board and manager performs is making sure interest rates on loans and deposits are set to assure a healthy margin.
Recently, rates on Treasury Bills have experienced an upward trend.
Also, in the past little while, some financial institutions have been raising deposit rates.
No doubt, under these circumstances, you as a credit union manager are feeling some pressure by members and maybe even by your board members to begin raising deposit interest rates.
Credit union CEOs need to be sure they are changing deposit interest rates based on the outcomes of stochastic modeling tools and not simply because the competition may be changing their rates.
Too many times we at TCT hear from CEOs, “I watch my competition and set my deposit rates according to theirs.”
As I’ve pointed out before, setting your rates according to your competition might work if the following were true:
- Your competitions’ income, expenses and economies of scale are identical to yours
- Your competition has the same short term and long term profitability goals as you
- Your competition has the same loan-to-deposit ratio as you
- Your competitions’ Interest Rate Risk is identical to yours
- Setting deposit rates at or above your competition assured member-satisfaction and/or profitability
- Your competition is not setting their deposit rates by watching their competition (which includes you)
Of course, most of the above points don’t apply to your credit union.
Too often, setting rates (deposit or loan) by watching the competition leads to unacceptable loan-to-deposit ratios and profit margins.
Instead of looking to the outside to set rates, credit unions should be looking within their own balance sheet and using empirical, statistically derived methods.
Dr. Randy Thompson, CEO of TCT, after research and statistical analysis, has developed a Margin Management tool which assures a healthy interest margin.
Dr. Thompson’s Margin Management model uses a “dividend payout ratio” which is formulated using a credit union’s deposit interest costs divided by interest income.
This “dividend payout ratio” is then used to set interest rates on deposits taking into consideration a credit union’s Interest Rate Risk parameters, loan-to-deposit ratio, budgets, and short/long term goals.
TCT’s Margin Management Tool provides these benefits to credit unions that utilize it fully:
- Higher profitability
- Control over deposit interest expenses
- An objective, non-emotional method for setting rates on each class of deposits
- An additional metric for managing Interest Rate Risk
- Establishes deposit rates according to a credit union’s financial health
- Can be used to project cost of funds and perform “what if” scenarios
- A planning tool for establishing budgets
- Continual readjustment of the dividend payout ratio as a credit union’s balance sheet and plans change
About the Author
Dennis Child is a 40 year veteran credit union CEO recently retired. He has been associated with TCT for 25 years. Today, Dennis enjoys providing solutions and training for credit union managers. He also uses his financial credentials and advisory skills to assist the Boomer generation plan and prepare for their retirement years. He and his wife, Geri, live in Logan, Utah. Dennis can be reached at firstname.lastname@example.org.